SLM Corporation (SLM) Earnings Call Transcript & Summary

Good morning, everybody. My name is Jeff Adelson, I'm the consumer finance analyst here at Morgan Stanley. Before we get started, I'm just going to quickly read some disclosures here. For important disclosures, please see Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and the use of recording devices is also not allowed. Do you have any questions, please reach out to your Morgan Stanley sales representative. Very happy to welcome to our conference today, first time, Pete Graham, CFO of Sallie Mae. Thanks for joining us, Pete.

Yes. Good to be here, Jeff.

So, maybe before we get into the meat of our conversation, let's start with a brief rundown of how the second quarter is shaping up in your view.

Yes. So we had a good first quarter originations grew 6% year-over-year. And so that gives us a good trend line going into the latter part of this year. For originations, we're not really going to see any real movement until we get into peak. That's when it matters. But we feel good coming into peak. Competitive dynamic is pretty balanced even with the exit of Discover, we've got some strong competitors that are private equity backed. But it's a rational marketplace, and we feel good about going into peak. Credit performance, we had good credit trends in the first quarter, and that's continued to trend into the second quarter, so feel good about that. Broadly, we reaffirmed guidance at the end of the first quarter and saw the metrics that matter we feel pretty good about.

And I think the trust data we look at, while it's not perfect, it seems to suggest more of a better quarter this time around versus, I think, what people were expecting. Any sort of early thoughts there?

Yes. Again, we've put in place a number of new programs to help borrowers that are in need. It's early in those programs life cycle. We're seeing the first of the borrowers complete their 3 monthly payments and cure and go back into performing status. So that's promising. We want to see a few more months of data on the sort of complete picture and start to normalize that. We want to see the performance of those borrowers that have gone back into performing status, they stay performing. But in general, we feel like the programs are performing well.

So stay tuned for that and maybe the next couple of quarters, I think.....

Yes. I think, look, in general, when we look at the repayment waves that happened in our business, second quarter and fourth quarter, and we look at the data around the usage of programs and the delinquency levels. When you look at that sort of altogether, the trends on the newer vintages are very similar to pre-COVID vintages. So that kind of tells us that we're dialing in appropriately on these new programs. But we'll have more to share after the second quarter.

And maybe we'll touch on the new programs in a bit, but I wanted to start with the recent loan sale you announced last week, $1.5 billion. So you're already tracking about $3 billion for this year. You're on track, executing on that $3 billion-plus path you laid out in the 5-year framework. Seems like a validation of what you're doing, strong demand for your product. Any way to maybe compare this deal versus the February 1 you did maybe in terms of characteristics of the loans. It does seem like from the outside looking in, on the demand side, the ABS spreads have continued to tighten. So the market seems like there's strong demand out there for your....

Yes. Yes. The most recent transaction itself, we're going to be in market with sort of the takeout securitization. So I wouldn't want to talk pricing or anything specific to that deal. We were very happy with the pricing on the first transaction we closed in February. We've completed an ABS on book funding in the early part of this quarter. That deal was 3x oversubscribed, which is kind of an indication of the demand. We were able to tighten pricing and upsize the deal from launch. So it's a good indication of what the market is like and the demand for the asset class. We feel like the market is very supportive of our strategy and feel good to have those 2 transactions done and behind us.

And it sounded like you were open to another sell later the year depending on the market. What would it take this at this point? And what does it take for the -- what does it take for you to actually execute on another one this year?

Yes. So when we laid out the framework back in December, we indicated that we were going to still be relatively flat on the balance sheet this year, just given the final CECL transition happens in January. Our guidance for the year is 2% to 3% balance sheet growth. And that's going to be kind of our guiding principle. We sized our loan sale transactions in anticipation of what we think is going to happen during peak, as we get into and through peak, if things turn out better than what we had anticipated, then we'll have a decision to make as to whether we carry a little bit more balance sheet growth through the year-end or if markets are favorable, we might do another loan sale.

And obviously, the repurchase story follows that loan sale model. Can you just talk about the near-term path or repurchases here, the cadence over [ '24 ]. And is 90 to 100 a quarter or something that is the right way to think about it? I know you talked about how you think you're going to do half of the repurchase authorization this year and the next, but maybe just some insight into what you're thinking there.

Yes. So what we said we were going to do for this year with regard to share repurchase was, one, funded incrementally as we completed loan sales. So that's been the approach we've been following. And then also, we indicated we're going to be more programmatic as well. So when we completed the February loan sale, we were in market very quickly after that and put in place a program that has us in the market every day. And generally, if prices are trending above trend line, we'll buy a little bit less. And if they're trending below trend line, we'll buy a little bit more, but aiming to be in market every day. And we will follow that same approach with the capital generated from this most recent loan sale.

Okay. And taking it back to the new programs you have out there with your borrowers, I think one perception is that -- that's out there is I want to lender starts doing more of this modification forbearance, it's a response to growing financial repayment difficulty from borrowers, but that's not what you're seeing, right? It's more about the credit administration practice change in late '21, which cut down on some of the flexibility back then. So is there any way to maybe frame what the mix of your assistance programs looks like today versus back then? Where the borrowers you were giving more forbearance to back then similar in that extended grace period recent graduate cohort?

Yes. So one thing we do know about our business is that the first 12 to 24 months upon entering the workforce after graduation, exiting their grace period. That period is the period of most stress for our borrowers. And if we can help them get through that phase, get their feet under them and establish good financial habits, they will generally perform very well once they get through that phase. And prior to 2021, we managed that phase with the generous sort of more flexible use of forbearance. When we ceased that in late 2021, we knew that we would need to develop some new programs to help bridge that gap. And the programs we rolled out in the fourth quarter of last year really intended to do that. As I said before, they're early days, but early indications are that those are performing as we anticipated. When we look at various payment vintages, over time, the trends do bear that out that the sort of peak stress in the portfolio payment vintages is in that first 12 to 24 months. When we look at the mix of the borrowers that are either in 30-plus delinquency or in some sort of modification program, the totality of that currently is pretty similar to what we saw in pre-COVID vintages. So that gives us another indication of -- we feel like we've sized it appropriately and it's behaving as intended. And we'll have more fulsome information to share after the second quarter earnings.

And one other way that I looked at it was, if you look before you made those changes, forbearance, which obviously includes some hardship in there as well. It was about 4% of your loans. Is that a potential way to think about the use of the extended grace as well going forward? Or...

Yes. It falls into that same bucket. If you look at year-over-year trends in the headline forbearance percentage, the hardship forbearance is pretty consistent at about 1%. And that growth in that disclosure is really all around the usage of that expanded grace period. Again, that's an additional 6 months of grace that's targeted and only available to new-to-repayment borrowers and attacks on to the 6 months that's built into the loan programs.

And is there any way to think about the magnitude of the increase in loss rates you saw in '22, I think it was about 120 basis points a year. Any way to think about how much of that was attributable to that policy change by any chance?

I think it's largely that. There were some other things that were going on in that time frame that were largely transitory. The bulk of that spike in loss rates was related to the ceasing of that flexible forbearance. And it just sort of accelerated losses into that period. We went for a period of time where we didn't have additional programs. And we've been on a continued improvement trend. Last year was a good step in the right direction. Our guidance around this year is for continued improvement. And we feel like we're on a good trajectory to get back to that sort of high 1s, low 2% net charge-off rate that we've said we aspire to get to.

And is there anything else that you're seeing today or in the environment that other than those policy changes makes you more confident in that glide path down to the low 2%, high 1?

Yes. I think it's just the performance trends that I talked about before, the sizing of the overall usage of programs, like it feels like we're getting to a point where we should be normalizing as we move through the latter part of this year. And we'll share more as we learn more going through time.

Okay. One thing that's been pretty topical of late is just competitive intensity in the industry. You obviously had another large player exit. And you're starting to hear a little bit more news flow or launches out there from smaller engines in the space. Can you maybe compare what you think the level of competitive intensity in the space is versus maybe a year ago or even pre-COVID?

Yes. I think what we're experiencing in this space is not dissimilar from other areas of banking, whereas big banks decide they don't want to be in a particular part of the industry, private equity-backed players will step into the void. When Wells exited, [indiscernible] stepped in and took some good market share there. There's been recent press around others entering the space and launching new programs in anticipation of peak. So I feel like, although Discover has pulled out of the market, there have been others that are going to be stepping in. But I think it's a very rational marketplace. We're the market leader, and so we expect to compete and take our fair share of the volume. But I think it's a very rational pricing environment. Nobody is doing anything that would upset a pretty balanced market.

And what are some of the behaviors that you've seen in the past or maybe you're starting to see today that would -- you would flag as a rational. I mean, are you seeing anything like that at all?

I have not seen any indications. We monitor that as we go through and into peak, no signs yet of anything that would be cause for concern. Obviously, folks are ramping up their marketing and getting ready for peak as we are as well. But we expect it's going to be a rational marketplace as we move through the peak this year.

And I just want to remind folks that if you have any questions, feel free to raise your hand, and we'll get to you. And also if you're listening on the webcast, my e-mail is [email protected], try to get to your questions be sent them in. Maybe taking it to NIM with the rate environment here, you're slightly asset sensitive at the front end. However, I think more of that fixed rate demand you're talking about more recently has made you may be less asset sensitive than you otherwise would have been as we look out there in the rate picture. So more of a natural buffer, I think, embedded in the model to eventual rate cuts. Is that the right way to think about it?

Yes. I think the important thing to understand, the thing that drives our asset sensitivity on the front end is really the securities portfolio that we hold for liquidity and capital purposes. And then once we get beyond sort of the front part of the curve, as you indicated, our overall loan portfolio is skewed heavily towards fixed rate, which makes us more liability sensitive. So in the context of a slower path of rate cuts this year, I think that's mildly positive, just given the repricing that happens in the securities portfolio. But over time, as we get into a declining rate environment, we'll be mildly benefit from that in terms of repricing of funding at a lower rate. We run a fairly balanced book. So we're not talking huge swings one way or the other. And for us, the sort of the trajectory of rates is really the important thing to think about.

And you put up the guide for the year, low to mid-5% for NIM. I think that included 5 rate cuts at the time market looks like it's pricing [ in 1 ] at this point. So I feel like what I'm hearing now is we've got a case for NIM staying close to where it is right now in that sort of mid-5 range. Is that right? Or what would make that come in a little bit weaker?

Yes. Again, I think our guidance was low to mid-5%. And in a higher for longer type time frame, we won't have as much pressure on compression of NIM as we might otherwise. So I think that's still the right ballpark for NIM. And I feel maybe we'll be at the midpoint or higher of that guidance, but we'll see as the year progresses.

And you laid out the 5-year framework for balance sheet growth and you're maintaining that flexibility to do loan sales. Is there anything else out there that would perhaps other than just more originations demand for your product caused you to maybe keep that balance sheet growth more moderate than the upper single digit you talked about?

Sure. The framework that we laid out in December, in our view, is a really balanced way to sort of shift to growth. And given the strong originations profile that we have, if we cease loan sales altogether, we would be growing double digits. And I think that puts a lot of pressure on funding, that brings additional regulatory scrutiny. And so we made a conscious decision to focus on the rate of growth of the balance sheet and use the sizing of the loan sales as sort of a balancing factor. So again, we're focused on sort of mid- to upper single-digit growth. As we go through time, the framework is very flexible. If we see really strong loan pricing, we can be at the low end of that range. If we feel like we're getting rewarded for growth on the balance sheet, we can hold a little more on the balance sheet. But we won't go to one extreme or the other. I don't see a scenario where we're growing the balance sheet double digits each year and nor do I see a scenario where we're not doing any loan sales in a given year.

And related to that, you talked about operating leverage roughly 60% expense growth at the rate of revenues are about 2:1 operating leverage. That's a big factor in your double-digit EPS growth within that framework. So what are the easiest expense levers you have to pull at this point? And does that trajectory of expenses change at all if you decide to lean in or pull back on that balance sheet growth story?

Yes. So the key thing in that framework on operating leverage is it's about the rate of growth, right? And so obviously, we need to have some growth of earnings by growing the balance sheet in order to make that equation work. If you think about the recent path, while we've been holding our balance sheet relatively flat, we've been making pretty significant investments in our risk management capabilities in the credit space, building out the edge services framework with the acquisitions of Nitro and Scholly. So those things are sort of behind us and won't be part of the growth rate going forward. At the same time, those investments that we have made, particularly in the Nitro acquisition and build-out of that framework is going to help continue to drive lower cost of acquisition and the investments that we've made in the credit and operations space moving towards more digital interaction with our consumers, providing more opportunity for self-service will give us an ability to scale there as well. And the other important thing to think about in our sort of operating framework is all of the loan sales that we're doing, we're continuing to service those loans. So as we build that base of loan service, that also gives us additional scale for what's turning to be more of a fixed rate of investment in servicing capabilities, it gives us more scale to spread that cost.

And does -- are you noticing any sort of -- type of increased scrutiny on the servicing side or the regulator side? There's been a focus from that competitor that exited there. Anything to highlight there?

Yes. Again, we've made investments and built capabilities to try and stay ahead of regulatory expectations. That's one of the key principles we operate by. So we feel like we've got a fairly buttoned up operation in terms of meeting the regulators' expectations in advance of them coming in. So I feel good about that. And again, I think as we start to grow the balance sheet, as we continue to do loan sales and build scale, that gives us more assets to spread those costs across.

And certainly not an easy product to service over time and collect on. So it seems like that's a pretty high barrier to entry for the competition.

Yes. We do one thing, but we do it very well.

Right. Maybe just taking it back to the moratorium. I mean the credit story here, one question that's kind of come in here is, from an investor's e-mail, why do you think you're not seeing any meaningful impact from the payment restart? Do you think it's because the Biden administration has done enough on the grace period, the on-ramp, consumers still in good shape? Or do you think it's more just the support you put in place for your borrowers?

It's -- that's a hard one to tease apart because we only know what we know. So when we're underwriting our loans, we know what the total sort of borrowing package that the individual borrowers have. We know whether they are also taking out federal loans. But as we move through time, we don't really get updated information as to whether they're in any kind of repayment program or the like in the federal space. We do know that we put our borrowers back into repayment in the fall of 2020. And that's been a pretty consistent indication to them that their obligations to us are different than their obligations to the federal government. As the federal program continued to evolve and borrowers will put back into repayment. We've been monitoring performance of those with and those without loans. The majority of our borrowers also have federal loans. And we haven't seen any real difference in performance between those two. I think some of that could be just where they are in the spectrum credit spectrum, the high cosigner rate and the like in our portfolio compared to the federal programs. But it also is down to them establishing those good financial habits because we've been requiring repayments since 2020.

And the Biden administration has been trying to launch another forgiveness initiative after the last one was blocked. Any sort of views on to program, how that might benefit or even reduce demand for your product down the line?

Look, I don't think there's a whole lot that's going to get done in an election year. And what I would say is the amount of focus that all of these sort of forgiveness initiatives has created there's really starting to be, I think, some bipartisan focus on the need to reform the federal system. There's been proposals floated on both sides of the aisle that have elements of what we think could be really meaningful reform, things like expansion of Pell Grants, targeted aid at HBCUs and really trying to target the federal dollars at the areas of most need. But at the same time, in order to balance that out, there would need to be reform in the lending programs as well. And I think on balance, those will be mildly positive. Again, we support most of the proposals that have been made. I think they're responsible proposals and ones that we think would be good for the overall economy.

And as we turn to capital here again, how are you thinking about the dividend? I mean I think a lot of investors are asking me when you're going to increase the payout here. I know you talked about the possibility of a special dividend at the investor forum. I guess, why not just lean into the recurring dividend instead of the special?

Yes. So part of our framework that we laid out was as we start to grow the balance sheet and create growth in the sort of organic earnings that would feed a growing dividend. And then the continued loan sales and the capital generated from that would fund our share buyback efforts. So over time, that's the delineation we would have between the 2 programs. At some point, we get to a theoretical point of diminishing returns around share buyback and amount of float in the stock outstanding. If we get to that point, we could do special dividends. But I think we would continue to keep separate the regular dividend and the growth of that fed by a growing balance sheet and organic growth in the business, separate from sort of the one-off capital generated from the capital markets transactions.

And is the last CECL phase [ and ] on the capital, is that maybe a key benchmark or goalpost to be looking at to pass here before you take any sort of action here on the capital of the dividend?

Yes. We've obviously got that in our sights. That's the reason that we targeted the lower 2% to 3% growth in the balance sheet for this year. Once we get past that, I think that gives us a greater degree of flexibility around allocation of capital to balance sheet growth as well as we begin to grow organic earnings to begin to increase the dividend.

And any sort of update on -- just taking it back to NIM jumping around a little bit here -- but any sort of update on deposit funding and what you're seeing this quarter on the flows? Obviously, the sale helps you out a little bit there.

Yes. In general, particularly this year because we're holding the balance sheet relatively flat. But even as we move into next year, where we've got a modest rate of growth, part of the reason for adopting that approach was to reduce the pressure on funding. And so we're rate-based gatherer, competing with other sort of rate-based gatherers. We look at what our competitors are doing in terms of pricing and follow suit. We're not going to be the highest rate on the page, nor will we be the lowest, and we tend to sort of track kind of the middle of the pack. If there are particular tenors that we need deposits in from an interest rate risk management perspective, we can adjust pricing at the margins to attract deposits at particular tenors. But the overall demand for deposits has been pretty strong and the market is pretty rational.

And I think you're targeting a little bit of a longer duration in that product right now at this point, given your loan book. Is that correct?

Yes, we -- I mean, we obviously will have a high portion of sort of demand deposits. We have CD products, we have brokered products that target different tenors. So again, we're attempting to run a match book either through the tenors where we're gathering deposits through the ABS programs or we also have derivative strategies we can employ to sort of balance out the profile.

And also just last quarter, the prepaid assumptions did come down to help your NIM. So I think some of that less consolidation activity, is that continuing? Or really dependent on the rate outlook, I would imagine as well.

Yes. I think that change was really kind of a roll forward of the historic look back we do around pre-payments and we've dropped off periods where we had a much different interest rate environment, a much higher level of consolidation activity. The trends around that have been pretty muted and continue to be so. I've heard folks in that space talk about the need for at least 100 basis points of rate reduction from here in order to get any meaningful uptick. So that's a good benchmark to keep an eye on. I think the other thing, too, is the optionality that's now there in the federal programs in terms of the potential sort of safety valves for borrowers if they get into distress could change the calculus because it won't be just a rate base decision, they'll be giving up something else. So that will be interesting to see how that plays out over time.

Is there anything that Sallie can do to maybe retain that customer as rates go down? I mean, I know it's a bit of a tricky process there?

I think it's something we think about. It's something we evaluate, but you kind of have that dynamic of, are you going to cannibalize your own portfolio in that effort. It's something we continually think about and look at, but we've got some time to evaluate before that's going to be an issue we need to deal with.

Okay. And maybe just before we wrap up here, is there anything that you want to message to investors or anything you think is a bit misunderstood in the story at this point?

I think we've hit all the hot topics that are on investors' minds. I'll just reiterate, we had a great start to the year with the first quarter. We reiterated our guidance for the year. Things are trending positively in the second quarter, credit and otherwise. And we look forward to talking with folks after the second quarter earnings.

All right. I think we'll end it there, unless there's any questions from the audience. Thanks for your time, Pete.

Thank you.

Thank you for joining us in the conference.